Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Shandong Haihua Co.,Ltd (SZSE:000822) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Shandong HaihuaLtd's Debt?

As you can see below, at the end of March 2024, Shandong HaihuaLtd had CN¥209.4m of debt, up from CN¥100.0m a year ago. Click the image for more detail. However, it does have CN¥1.30b in cash offsetting this, leading to net cash of CN¥1.09b.

How Strong Is Shandong HaihuaLtd's Balance Sheet?

The latest balance sheet data shows that Shandong HaihuaLtd had liabilities of CN¥2.04b due within a year, and liabilities of CN¥549.2m falling due after that. On the other hand, it had cash of CN¥1.30b and CN¥2.79b worth of receivables due within a year. So it can boast CN¥1.49b more liquid assets than total liabilities.

It's good to see that Shandong HaihuaLtd has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Shandong HaihuaLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Shandong HaihuaLtd's EBIT dived 12%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is Shandong HaihuaLtd's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Shandong HaihuaLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Shandong HaihuaLtd's free cash flow amounted to 34% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shandong HaihuaLtd has net cash of CN¥1.09b, as well as more liquid assets than liabilities. So we are not troubled with Shandong HaihuaLtd's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Shandong HaihuaLtd (1 doesn't sit too well with us!) that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.